A plan that forces you to save for retirement

Prof suggests plan to combat U.S. retirement crisis

It’s time for the U.S. to create a mandatory, defined-contribution plan, not unlike those in other parts of the world such as Australia or the United Kingdom. Or so says Meir Statman, author of “What Investors Really Want” and a professor at Santa Clara University.

“Libertarian-paternalistic nudges have moved many non-savers into defined contribution retirement savings, but left many behind, along with those with limited access to defined contribution retirement savings plans,” Statman wrote in a paper that’s currently being considered for publication in a highly regarded professional journal. “It’s time to switch from nudge to shove and replace libertarian-paternalistic voluntary defined-contribution accounts with fully paternalistic mandatory defined-contribution accounts for all.”

In essence, Statman wants to create a new type of retirement plan that address the retirement-savings crisis that exists in the U.S. and that fits between Social Security and existing 401(k)-type plans where contributions are defined and voluntary.

TAXES

Big tax bills can devastate your retirement
savings. MarketWatch's Robert Powell and Andrea Coombes talk about strategies to employ before and during retirement to lower your taxes.

“It’s a retirement savings solution centered on a paternalistic second layer of mandatory private defined contribution savings accounts in a retirement savings pyramid, above by the paternalistic first layer of Social Security and below the libertarian third layer of voluntary savings.”

And having that kind of plan, he said in an interview, would go a long way toward addressing the retirement savings crisis that exists, especially for “non-savers,” who—at the moment—are likely to subsist solely on Social Security in retirement. “I certainly hope there’s violent reaction to my plan,” he said. “The referees at the journal (where its being reviewed) said it’s going to make some people angry. And that’s good.”

According to Statman, these mandatory savings accounts would be private accounts, much like current 401(k) and IRA accounts, except that they would be mandatory and unavailable before retirement age. “The mandatory savings accounts would add little burden on savers, as they would largely replace voluntary 401(k) and IRA savings,” he wrote. “Yet they would add great benefit to non-savers who fail to accumulate sufficient retirement savings.”

Savers, he said, should not really care whether the government forces them to save. They are going to save regardless. “Other than feeling oppressed because I now have to do it because the government said so, the effects other than ideology are zero,” he said. “But the effect on those who have a problem saving would be profound.”

To be sure, the U.S. would not be breaking new ground in creating mandatory defined contribution savings plans. Such plans exist in several countries outside the U.S. And “these hold lessons about plan features we are wise to adopt and flaws we are wise to avoid,” he wrote.

According to Statman, the reason why the U.S. needs such a plan has to do with human behavior. Some people are built to save, while others aren't, he said. “Self-control overcomes temptation, but not everyone possesses sufficient self-control,” he wrote. “Mandatory savings substitute external control for self-control by limiting income available for spending.”

“Self-control overcomes temptation, but not everyone possesses sufficient self-control ... Mandatory savings substitute external control for self-control by limiting income available for spending.”
Meir Statman

And while he does acknowledge that each of us is born with a capacity for self-control, some are born with a greater capacity than others. “We don’t have a general retirement savings crisis,” he said. “We have two populations, some people have too much money and some people have too little. We have some people with good self-control and forward thinking and they don’t really need anything mandatory. But then there are other people who need it.”

And when Statman thinks about the retirement savings crisis in the U.S. it’s more about those who have no self-control. “For those who need a little extra kick, (my plan) forces them to save whether they like it or not,” said Statman.

He also noted that conscientious people accumulate more wealth than less conscientious people. “It’s hard to accept, but some people in our country are children forever in our country,” he said. “And in the same way that you would not let a 3-year-old cross the street on his own, you would hold their hand; some people need hand-holding until they are 70.”

And lastly, he noted, that frugality—bolstered by self-control—underpins savers.

Now it’s true that the U.S. has made moves to help non-savers become savers through the use of automatic enrollment in defined contribution plans. But even automatic enrollment plans aren’t panaceas. “Employees who do not enroll in defined contribution savings plans along with employees who enroll but contribute little and employees who cash out before retirement are doomed live in retirement on little beyond Social Security benefits,” he wrote.

Of course, part of the retirement security problem in the U.S. can be blamed on financial illiteracy. “Financial illiteracy hampers non-savers, perhaps obscuring the likelihood of destitution in retirement,” he wrote.

Another advantage of Statman’s plan is this: It likely reduces the odds that the savers of the world will have to pay—in higher taxes—to support the non-savers down the road. “We are our brother’s keepers,” he said. “So even if it didn’t burden us directly I care enough about others to pay higher taxes to support them.”

So what specifically does Statman want?

Well, Australia’s superannuation plan is one model. Employers there currently withhold and contribute on behalf of their employees 9% of wages or salaries (it’s scheduled to rise to 12% by 2019) and employees can voluntarily contribute even more. (Voluntary contributions currently average 3%.) In other words, Australians are or will be saving 15% of earned income. By way of background, two-thirds of middle-income (those making $40,000 to $99,999) American workers are saving less than 5% of their annual income for retirement—with nearly a quarter saving nothing at all, according to a LIMRA study. (See this chart.)

To be fair, there are drawbacks to Australia’s plan. For one, costs are high and “the interests of beneficiaries are not always paramount,” Statman wrote. And Australian employees aren't necessarily engaged in their retirement program, especially when retirement is far in the future and because the money for it comes from employers and employees cannot withdraw it before retirement.

The other and perhaps model to introduce in the U.S. is the British National Employment Savings Trust (NEST), a mandatory defined contribution savings plan introduced in October 2012 and aimed squarely at non-savers, according to Statman.

NEST calls for mandatory contributions from both employers and employees, Statman wrote. Employers are mandated to pay into NEST at least 2% of employee earnings in the 2012/13 tax-year and employees are mandated to pay at least 1%. Mandatory contributions are scheduled to reach a total of 8% by 2018, composed of 3% from employers, 4% from employees, and 1% from the government.

According to Statman, the NEST plans have some features worth adopting in the U.S. For instance, NEST prohibits borrowing and withdrawals. What’s more, British employees cannot withdraw retirement savings before they reach the age of 55. Plus, the default investment options are 46 target-date funds set at one-year intervals. (In the U.S., the intervals are usually set at five years.) The NEST target-date funds tend to own less or no stocks compared with U.S. target-date funds. Plus, there’s centralized investment management so fees are low, on the order of 0.3%. The British plan is good, he said, because it limits costs unlike the plan in Australia.

Now Statman is, for the record, a bit of realist. He knows that efforts to create, for instance, an automatic IRA in the U.S. have largely failed to date. And efforts to create a mandatory defined contribution plan would fail even more so, he said.

(The most recent version of the Auto-IRA plan, which has been kicking around since 2009, “would require employers in business for at least two years that have more than 10 employees to offer an automatic IRA option to employees, under which regular contributions would be made to an IRA on a payroll-deduction basis.”)

Still, Statman believes the British NEST mandatory retirement plan can serve as a good model for an American plan.

For the record, Statman said his plan is different from the guaranteed retirement account proposed by Teresa Ghilarducci, a professor at the New School. Ghilarducci’s plan calls for mandatory savings and a guaranteed return, or what Statman said is an expansion of Social Security, a defined benefit plan.

Statman’s plan, by contrast, calls for mandatory savings with investment returns dictated by the account owner’s investment decisions, exactly how it happens with traditional 401(k) plans. “People should see the relationship between what they do and what comes out of it,” he said.

To be fair, Statman says the NEST plan is no panacea. For instance, people with no income will continue to have no source for savings, and stock market crashes and raging inflation can decimate accumulated savings, he wrote.

“But the problem of retirement income is severe, and solutions must be identified, debated and implemented,” he said. “We don’t have to force people to eat spinach, but this is really important to leave to just people’s taste and education about financial nutrition.”

Mortgage Rates

Powered by

This advertisement is provided by Bankrate, which compiles rate data from more than 4,800 financial institutions. Bankrate is paid by financial institutions whenever users click on display advertisements or on rate table listings enhanced with features like logos, navigation links, and toll free numbers. Dow Jones receives a share of these revenues when users click on a paid placement.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.